The Political Economy of German Unification

pressure to achieve rapid improvements in the firm's financial
position: the incentive is all the stronger when managers are on
short-term contracts. One way to boost apparent performance is to
exploit the firm's relational contracts for short-term profit taking.

The implications of hostile takeover for corporate performance
go beyond the direct effects on target firms. The whole business
environment is poisoned. Kay argues that relational contracts are
more difficult to make in business environments where such
changes of control are common. This is because 'the parties are
less certain that the terms of the relational contract will be honoured' ( Kay 1993, p. 60). If changes in corporate control are frequent and lead to reneging on relational contracts in the interests of
short-term profit-taking, then business partners become less willing to form such contracts. On this argument, hostile takeover
entails a negative externality in that the practice makes relational
contracts less common than they would otherwise be. In Germany,
to move towards the UK's ease of transfer of corporate control
would hinder commitment to relationships of trust and cooperation between business 'stakeholders'. This would tend to deracinate Germany's 'social market economy'.

Finally, if relational contracts contribute to business performance
over the long run, and if hostile takeovers are unfavourable to constructing relational contracts, then it must be the case that a financial
system encouraging hostile takeovers exerts an adverse influence
on corporate performance compared to a financial system that does
not favour hostile takeover. In this case, the advantage of the German system of corporate governance and finance-industry relationships is that it does not constitute a transmission system from
financial short-termism to industrial short-termism.

In Germany, long-term bank-industry relationships through
interlocking supervisory board membership, the corresponding
willingness of banks to forgo short-term capital gain in favour of
long-term profitability, and banks' use of voting power to protect
companies against hostile takeover ( Franks and
Mayer 1990; Owen Smith 1994; Smyser 1992) all favour industrial performance relative to the UK.

Conclusion

The German financial system is not bank-based in many of the
ways commonly thought to define it as such: the minimised agency

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